For the moment we appear to be in limbo, where stocks and other risk assets will rally no matter what? The view seems to be that if European sovereign debt improves, then risk will do well. There is little fear right now, as the assumption is that if sovereign debt does poorly, Germany will relent and the ECB will officially being printing money (I say officially, because it is getting harder and harder to believe they are truly “sterilizing” their purchase in a true market neutral fashion).
So that seems to be the idea out there, be long risk because if Europe improves, you will win, and if Europe gets worse, it will print, and you will win. That just doesn’t make sense to me, as I think Germany is further from capitulating on printing than the market seems to have priced in.
ECB rate cuts should be expected. It wouldn’t surprise me to see another surprise announcement. The issue is that the last one had absolutely no effect. It didn’t even translate to improvements to Spain or Italy for a full 24 hours, and France didn’t get the benefit for even 48 hours. The rate cut is likely to happen, stocks may bounce on it, but who benefits? The banks that are funding at the ECB would benefit, I guess, but that would make the entire system even more reliant, and would be weird that they can fund better than the sovereigns. I would think that France, at these yields would move with ECB rate cuts, but it really didn’t last time – which is concerning. French 10 years now trade at Bunds + 163 (that is almost 2x Bund yields). Belgium, the other Dexia supporter is now yielding about 4.5% for 10 years which is the highest level of the year – another sign of weakness.
The market has been rebounding on talks about “political union”. Maybe that is coming, and as much as the market might want Germany to take the other countries under their umbrella, I’m not so convinced the other countries want that.
The ECB or Germany could easily have come into this week with some announcements to drive the markets a lot better. They didn’t, and I believe that is because there is real disagreement on what is the best way forward. Germany is extremely nervous about printing money and creating inflation. Some of that is purely “historical” fear and might be overcome, but they must see how every time they have bent the rules recently, it hasn’t worked. The problem is getting worse, and a big part of the reason it is getting worse and spreading, is because of their attempted fixes.
I think in the end, Germany is likely to capitulate (unless one of the PIIGS decides that it is in their own best interest to exit the Euro) but not until there is a lot more pressure on the markets and other alternatives – ECB rate cuts, some form of actual EFSF launch, etc., have been tried.
The last time everyone was so confident a trade couldn’t lose was when gold was approaching 1900 for the first time, and every possible scenario was for gold to go up. It didn’t. On the other hand, gold is now back to almost 1800 and is doing it quietly with little fanfare. The everything is good for stocks scenario seems too dangerous and unrealistic, at least up here at 1255 on SPX. The ECB and Germany may accommodate what the market wants, and economic data may be supportive, but I think there will be another round of real fear before we get there. The more people start discussing Portugal and Spain in addition to Greece and Italy, the sooner we will see that fear materialize.